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Thursday, March 22, 2012

16. Owners vs. Managers

The Concise Guide To Economics

by Jim Cox

16. Owners vs. Managers

In the relentless attack on economic freedom waged by statists, the modern corporation has been targeted for scorn. The perfectly valid theory that a profit-maximizing firm will generate efficient production for consumers has been turned into a "judo" argument against the free market. This theory states that the old nineteenth century firm was an efficient producer since the owner (who wanted to maximize his profits) was one in the same with the manager (who made actual day-to-day decisions). However, today the modern corporation is run by "hired gun" managers who are not the owners of the firm and its assets, and thus are less interested in profit maximization than in a comfortable existence, while the owners are often passive investors uninvolved in the decisions of running the business.

Thus, according to these critics the firm will not be efficiently managed for consumer benefit but will result in management taking advantage of the owners for their (the managers') personal benefit. From this viewpoint the statists argue for regulation and denunciation of the free market process--a process which often results in these large, corporate business enterprises. (First, let me acknowledge the dichotomy of interests which does exist between the owners and the managers; a dichotomy which also exists even with a single owner and a single-employee sized firm. The owner will be diligent in his behavior, whereas the employee does gain personal benefits from slacking. Obviously, the benefits of having employees outweigh the negatives of having employees since we find a world of firms with employees instead of one-man enterprises.)

The free market has inherent remedies for such ill-behavior on the part of the "hired-gun" managers. At least four offsetting influences will tend to mitigate the dichotomy of interests: First, any abused passive investor can always sell his share of stock in such a corporation. While this will not save the investor from past personal losses he can at least extricate himself from the abuse. But if this response is widespread, the effect of many small investors selling their stock will put downward pressure on the price of the stock. A reduction in the price of the stock will surely get the attention of the major investors who do involve themselves in the decision making of the corporation--the board of directors, if no one else--who can take meaningful action!

Second, it is very, very common for managers to be paid in stock or stock options in a corporation. Thus the managers are owners who will benefit from an increase in the stock value--as the passive investors prefer--and lose the opportunity for gain from a decrease in the stock value; a conjoining of interests!

Third, who would the board of directors--as owners interested in profit-maximization--choose to manage their corporate assets? A "natural selection" process will occur in the market as those managers who have shown their determination and ability to create profits will be promoted to the pinnacles of corporate management, while those more interested in personal comfort at the expense of the stockholders will be passed over.

Admittedly, none of these three listed influences will totallyovercome the dichotomy of interests problem, but as usual, the free market inherently has appropriate motives for efficiency. The final solution to any remaining negatives can and is overcome by the effects of corporate raiders. Corporate raiders--the mis-analyzed and under-appreciated cleansing acid of the corporate community--can be relied on to serve the interests of consumers and efficiency.

Any poorly managed firm will, to that degree, be ripe for a buyout by those specializing in profiting by the spread between the actual and the potential value of a firm's assets. Corporate raiders will approach current owners of undervalued assets with the offer of a better price in order for the corporate raider to reap the profits available from a change in management of those assets. A well-managed firm--one whose potential stock value and actual stock value are already in line--will be passed over as a target of a buyout.

The problem of owners versus managers is therefore most acute when there is no marketable stock share as in citizens' "ownership" of government enterprises. Rather than agonizing over for-profit corporation management, the theorists of management abuse of owners should instead direct their attention to government enterprises.